4th July 2016
Dividend cover for the index of 350 leading shares, a measure of how affordable and sustainable company dividends are, has fallen to its lowest level since the end of the recession, according to new research by The Share Centre.
The analysis, using data from The Share Centre’s Profit Watch UK report and the Capita Asset Services UK Dividend Monitor, shows that dividend cover has fallen by 38% in the past year, dropping to 0.98x from 1.63x.
This means companies paid out more in dividends than they made in profit. Based on profits of £76.4bn made by the UK’s top 350 listed firms in the year to the end of December 2015 and reported by the end of March 2016, dividend cover is now at its lowest level since the third quarter of 2009, when it stood at just 0.73x. It has fallen for four consecutive quarters.
Dividend cover is a ratio defined by profit after tax divided by dividends paid. The higher the ratio, the greater the comfort that a company can afford, and can sustain, its dividend pay-outs. A lower ratio means a cut in the dividend is more likely if profits fall.
Net profits of the UK’s largest firms, especially those in the basic materials (predominantly mining companies), oil and gas and financials industries, have been hit hard by global headwinds. Falling commodity prices have hit producers’ profits, while negative interest rates have impacted banks’ margins. As a result, net profits across the 350 have fallen by 54%, from £165.7bn a year ago. In contrast, FTSE 350 dividend payments have risen to £78.4bn, up from £71.2bn over the same period. This is the first time since 2009 that dividends have exceeded net profits.
Three sectors weigh heavily on dividend cover, but fall is widespread
Banks, miners, and oil & gas companies had the largest impact on dwindling dividend cover in the top 350. Within the broader basic materials industry, the mining sector saw dividend cover turn negative (-1.06x) as miners reported losses of £7.7bn in 2015. With a similar loss of £8.0bn among oil and gas producers, this sector saw dividend cover fall into negative territory – a drop mirrored by oil services and distribution companies. In the banking sector, profits were insufficient to cover the dividends: banks saw cover fall from 1.61x a year ago to 0.52x.
Excluding banks, oil producers and mining sectors, companies made more in profit than they distributed in dividends, with cover standing at 1.65x. However, even without these influential sectors, cover across the remaining companies in the 350 was still down from 1.84x a year ago. Cover fell in all but one broad industry group. For instance, the consumer services group (which includes supermarkets) saw dividend cover fall from 1.75x to 1.10x in the last year, with net profits barely outstripping dividend payouts, despite the decisive action to cut dividends from Tesco.
Healthcare bucked the wider trend, as the industry saw its coverage ratio rise to 1.69x from 0.99x a year ago. This was driven by the pharmaceuticals sector. Although dividends barely increased, it saw net profits double to £11.5bn, largely down to the profit GlaxoSmithKline made on the sale of its oncology business to Novartis.
At the more detailed sector level, almost one third of the 38 sectors paid more in dividends than they reported in profit.
FTSE 250 v FTSE 100
The stronger profit growth of mid-cap companies led to the FTSE 250 seeing higher dividend cover than the FTSE 100. It currently stands at 1.56x, compared to 0.89x in the FTSE 100, reflecting the 34% fall in net profits in the FTSE 100, compared to the 7% increase in the FTSE 250. However, the market reaction to the referendum result suggests that FTSE 250 profitability will deteriorate as the economy slows.
The ratio in the FTSE 100 is at its lowest level since the third quarter of 2009, with net profits now lower than the current level of dividend payouts.
Helal Miah, research investment analyst from The Share Centre, said: “Plummeting profits in the FTSE 350 have undermined dividend cover across the board, even before the impact of a Brexit vote is fully felt among listed companies. Global headwinds took their toll on the UK’s largest, most internationally exposed sectors, with commodity firms and banks especially seeing their profit margins and dividends under increasing pressure. However, more worryingly for investors, the stress on dividend cover has been rather more widespread, and not limited to a small cluster of sectors.
“Finance directors will usually try to ride out a soft patch for profits and hold the dividend steady for as long as they prudently can. Eventually, it is important to face facts. We have already seen companies announce a slew of dividends cuts, many of which are still to filter through. This will protect companies from unaffordable outflows of cash. In an ideal world, investors would see dividend cover recover owing to a bounce-back in profits, rather than from cuts in the dividend. With the outcome of the Referendum likely to hit profits of companies dependent on the UK economy, investors should expect cover to fall further or brace themselves for dividends to be cut; they should be cautious of companies that have a combination of a high yield, and a low cover.
“There had been bright spots amidst a gloomy outlook for many income investors, with some sector specific success stories. Health care dividends were more heavily supported, while mid cap companies once again outperformed their large-cap peers, with rising dividends being supported by climbing net profits. The recent referendum vote could favour companies with large overseas operations or big export margins, while those dependent on the UK economy can be expected to suffer. With this in mind, well-researched stock picking is all the more important to investors.”
The researchers used data published in the The Share Centre Profit Watch UK to calculate rolling annual profits from the UK each quarter. They calculated rolling annual dividends from the Capita Asset Services UK Dividend Monitor in the same way. Dividends were calculated with one quarter lag compared to profits because dividends are paid after profits are declared; the researchers judged the lag made for a better comparison between the two. The dividend data utilised incorporates a revised historic series released by Capita, accounting for the new dividend taxation changes. This has necessitated a recalculation of the historic dividend cover series calculated by The Share Centre’s researchers.
It should be noted that all figures are collated on a whole index or whole sector basis, and have not been adjusted for individual companies that do not pay a dividend, but whose profits/ loses have been included in the aggregate calculations.
Data Source for Profit Watch UK: The Share Centre via FactSet Research Systems Inc.
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